Investors who want to earn regular passive income might want to consider purchasing monthly dividend stocks. These can earn them a steady income, allowing them to cover monthly expenses or boost up their savings. But are monthly dividend stocks safe?
Monthly dividend stocks are a safe and reliable investment that offers regular cash flow besides capital gains. Dividend-paying firms are also premium businesses with high yields and strong financial bases. Still, making high monthly payouts might hamper company growth, affecting future dividends.
In this article, I will explain further what monthly dividend stocks are and why they make a relatively safe investment. You will also find out what makes these stocks appealing to investors and how you can invest in them safely.
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Risks Associated With Monthly Dividend Stocks
Monthly dividend stocks are generally considered safe investments, and they make a suitable addition to a smart investment portfolio. However, like any other investment, they come with certain risks that income-seeking investors need to be aware of.
Some of the risks might not be that obvious, but they exist nonetheless and could affect your portfolio adversely when you least expect it.
Let’s discuss some of the potential dangers associated with monthly stock dividends that you need to consider before investing in these stocks.
High Payout Ratios
A high payout ratio such as between 55 and 75% might not sound like such a terrible thing. However, it could be unsustainable as there’s little margin for error to continue distributing payouts if business results were to decline.
For instance, business development companies offer dividends with high payout ratios, but they use considerably high financial leverage and complex business models, making them risky.
Dependence On Capital Markets
Stock prices depend heavily on the capital markets and are affected by market swings, investor sentiments, market news, and rising interest rates. And since most monthly dividend-paying companies are heavily influenced by the performance of the overall market, your income could take a hit during periods of unexpected market upheaval.
A company might also need to increase its payout if the price of its stock goes up.
High Volatility
Many monthly dividend-paying stocks might be quite volatile. While this makes them potentially yield higher returns, they also pose greater risks. Examples might include business development companies, mortgage REITs, and closed-end funds.
Due to their speculative high-yield plays, these companies might not sustain monthly dividend payouts during a recession. As such, you might want to approach them with extreme caution.
Risk Of Harming Future Company Growth
A high dividend yield might not be a good thing after all.
It means that the company is giving out most of the profits it makes to investors instead of reinvesting in company growth. This can cause the management to leverage their balance sheet rather aggressively, sustaining company growth with debt, which might lead to potential dividend reduction in the near future.
Most Monthly Stock Dividends Come From Risky Industries
Most of the higher-paying monthly dividend stocks come from potentially risky businesses such as business development companies and real estate investment trusts. This makes analyzing individual stocks’ underlying fundamentals before committing to investing in them doubly important.
How To Invest Safely in Monthly Dividend Stocks?
Now that you know the risks associated with monthly stock dividends, how do you invest wisely? When investing in these stocks, it’s essential to look at other factors and not allow yourself to be swayed solely by the payment schedule.
These key factors include choosing:
- Stocks that match your risk tolerance and income needs.
- Those that have a sound recession performance.
- Stocks whose dividend yield compare favorably against industry peers.
- Dividend stocks with sound fundamentals and a solid underlying business model.
- Companies with a long history of consistent dividend payouts.
- Companies that increase their dividend payout rate over the years.
- High-quality dividend stocks with safe, high-yield dividends and long-term growth potential.
- Companies with a viable dividend-paying ratio, an indication that they reinvest in growing the business.
Ultimately, investing safely in monthly dividend stocks means avoiding stocks with high payout ratios and short dividend payment histories, as they tend to have higher risk levels. Besides, high dividend payouts could eventually undergo a reduction or even outright suspension.
To avoid such an eventuality, choose stocks with healthy payout ratios of between 35 to 55% because such payouts are more sustainable in the long run.
Research the Companies
While a monthly dividend stock might seem like a worthwhile investment, it’s important to research carefully into the company before committing your money.
The thing is, some companies pay out dividends even when the company is not performing to please their shareholders. Continuing to distribute dividends helps prevent a negative impact on the stock’s share price.
It also attracts investors, consequently increasing the stock’s value.
In some cases, a stock price could go down, but the dividend could remain unchanged. Given all these varied scenarios, you might want to take a deeper look into how your potential dividend-paying company uses dividends in its overall corporate strategy.
It’s also almost important to note that investors consider dividends an indicator of how financially sound a company is. As a result, they could devalue a stock if they believe the dividend will suffer a reduction, thus lowering the share price.
Why Monthly Dividend Stocks Appeal to Investors?
There are several other reasons why investors find monthly dividend stocks attractive. Some of the appealing features of these dividends include:
- Monthly dividend stocks allow for easy budgeting. The predictable monthly income makes budgeting easier for most people. This is especially so for retirees living off their dividend income. Furthermore, the payouts match most standard bill payments, such as mortgages or utilities.
- The monthly dividend stocks compound faster. Monthly dividends compound faster than quarterly or annual dividends. This is because the more often you receive a payout, the faster you can reinvest it to purchase more shares. Doing so also generates a higher dividend income in the long run.
- They rise above inflation. Most monthly dividend stocks deliver high yields. What’s more, the payouts usually increase over the years, outpacing the inflation rate, a factor that appeals to investors desiring to generate a viable cash flow. It also makes it possible to build a portfolio dedicated to supporting retirement living.
- They provide tax benefits. Tax on dividends is generally lower than the tax imposed on a regular income. For instance, individuals whose ordinary income tax bracket lies between 35 and 37% have their qualified dividends taxed at only 20%, while those in the 10 -12% tax brackets pay zero tax. This makes monthly dividend stocks a tax-efficient means of building an income.
- They provide supplementary income. Monthly dividends provide additional income to salaried investors while retirees can live off their payouts.
What Are Monthly Dividend Stocks?
Monthly dividend stocks are those that feature a monthly payment schedule.
What this means is that you receive 12 dividend checks per year. This mode of dividend payment is a departure from most dividend stocks since they mostly make quarterly or annual distributions.
Some of the most common monthly dividend payers include:
- REITs, real estate investment trusts (REITs).
- Closed-end funds (CEFs).
- Business development companies (BDCs).
These funds and companies typically sport remarkably high yields, often more significant than other dividend payers or the market average.
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Conclusion
Monthly dividend stocks are fairly safe. They are reliable, provide a guaranteed cash flow, and can help you meet your monthly expenses.
However, to make the most of your investment, ensure to choose stocks that match your risk profile and select stocks with growth potential, sound valuations, and generous payouts. This way, you will earn a steady income and even save towards your retirement.
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